Wednesday, January 30, 2013

The Health Care Law and Retirement Savings

Because of its definition of affordability, beginning next year the Affordable Care Act may affect retirement savings.

Employer contributions to employee pension plans are exempt from payroll and personal income taxes at the time that they are made, because the employer contributions are not officially considered part of the employee’s wages or salary (employer health insurance contributions are treated much the same way). The contributions are taxed when withdrawn (typically when the worker has retired), at a rate determined by the retiree’s personal income tax situation.

Employees are sometimes advised to save for retirement in this way in part because the interest, dividends and capital gains accrue without repeated taxation. In addition, people sometimes expect their tax brackets to be lower when retired than they are when they are working.

These well-understood tax benefits of pension plans will change a year from now if the act is implemented as planned. Under the act, wages and salaries of people receiving health insurance in the law’s new “insurance exchanges” will be subject to an additional implicit tax, because wages and salaries will determine how much a person has to pay for health insurance.

While much about the Affordable Care Act is still being digested by economists, they have long recognized that high marginal tax rates lead to fringe benefit creation. And the Congressional Budget Office has concluded that the act will raise marginal tax rates. Were an employer to reduce wages and salaries (or fail to increase them) and compensate employees by introducing an employer-matching pension plan, the employee is likely to benefit by receiving additional government assistance with his health-insurance costs. The pension contributions will add to the worker’s income during retirement, except that the income of elderly people does not determine health-insurance eligibility to the same degree, because the elderly participate in Medicare, most of which is not means-tested.

Take, for example, a person whose four-member household would earn $95,000 a year if his employer were not making contributions to a pension plan or did not offer one. He would be ineligible for any premium assistance under the Affordable Care Act because his family income would be considered to be about 400 percent of the poverty line.

If instead the employer made a $4,000 contribution to a pension plan and reduced the employee’s salary so that household income was $91,000, the employee would save the personal income and payroll tax on the $4,000 and would become eligible for about $2,600 worth of health-insurance premium assistance under the act. (The employer would come out ahead here, too, by reducing its payroll tax obligations).

Even though the Affordable Care Act is known as a health-insurance law, in effect it could be paying for a large portion of employer contributions to pension plans. This has the potential of changing retirement savings and the relative living standards of older and working-age people.

Supply and Demand (in that order)

The basic tools of supply and demand help immensely to understand and predict everyday events in our world. These days, many of those events are related to the Redistribution Recession of 2008-9. But I also look at other issues related to fiscal policy, labor economics, and industrial organization.